As economic storm clouds gather, remember: Lines of credit are fair-weather friends

The Bank of Canada just raised interest rates, and the job market is sluggish. It’s the kind of environment where it makes sense to review your line of credit balance, if you have one.

Lines of credit are what I call fair-weather friends. When interest rates are low and the economy is firing on all cylinders, they can be a cheap and flexible way to borrow. But when rates are heading up and financial headlines start to sound concerning, beware.

Let’s talk about the good first. A line of credit works somewhat like a credit card. You take out the amount you need, up to a set limit, and pay interest only on what you borrow. Credit frees up as you repay.

But interest rates on lines of credit are generally much lower than those you’d pay on credit cards. And lines of credit backed by home equity, known as home-equity lines of credit or HELOCs, often offer interest rates that are lower than those available even on personal loans.

The perennial trap with lines of credit even in good times is that they usually allow borrowers to make interest-only payments. For many people, that quickly becomes a slippery slope into unmanageable debt.

Here, though, I want to talk about the dangers of lines of credit when the going gets tough. The first thing to know is that lines of credit typically have variable rates. When the Bank of Canada hikes its trend-setting policy rate, as it did on Wednesday, rates on lines of credit quickly mirror those movements.

Today, the average Canadian with a HELOC balance owes just under $60,000. With a competitive 4.95-per-cent interest rate on that balance, a single central bank rate hike of a quarter of a percentage point would increase the interest payment by about $12 a month.

That may not seem much, but when central banks start raising rates, they rarely roll out a single hike. Two, three or more rate increases over the span of a few months can significantly drive up the size of your line of credit repayments, if you have a large balance.

Then there’s something very few people, in my experience, know about lines of credit. Lenders can often lower credit limits or ask you to repay what you owe on short notice.

This isn’t common, but it’s not a purely theoretical scenario. I’ve been reporting on personal finance for about a decade now, and I’ve seen this happen a handful of times (and remember, we only hear about it when a borrower decides to tell a journalist about it).

When do banks tend to call in credit lines? Sometimes they’re worried about an individual borrower’s risk profile. Other times, it has to do with what’s happening in the broader economy. Lenders can get nervous about large lines of credit debts during economic downturns, when unemployment is climbing or property values are falling.

That’s why it’s never a good idea to treat a line of credit as your emergency fund. It could shrink when you need it most, or you could be asked to repay what you borrowed when you can least afford it.

Of course, Canada is not in a recession right now. The economy, so far, continues to limp along. But the forecast isn’t great, andthe Bank of Canada is expected to roll out several more rate hikes in the coming months. If you owe money on a line of credit, reducing or paying off that balance is a good way to shore up your personal economy.

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Erica’s personal finance reading list

Despite the rate hike, this broker believes in variable mortgage rates

David Larock, a Toronto-based mortgage broker, spells out the case for going variable even as rates are set to keep climbing – with plenty of caveats.

The Iran war is coming for your winter heating bill

High diesel prices are about to hurt consumers beyond just pain at the pump, writes Global News’ Uday Rana. Households who rely on heating oil, which has a composition similar to diesel fuel, are likely in for big bills.

She dodged a phone scam, so fraudsters called the cops on her

I’m doing a fair bit of my own reporting on financial fraud these days, but this story about a Nova Scotia consumer left me gobsmacked.

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Podcast fansSubscribe to Stress Test on Apple podcasts or Spotify.

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Chart of the day

As this chart shows, 4½ years on, the housing correction is an Ontario and B.C. story.

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Today’s financial tool

The Measure of a Plan, a Canadian financial literacy website, has been around for years. But its Savings Goal Solver remains hands down my favourite tool for back-of-the-envelope calculations about how much to save for retirement and other financial targets. I like the ability to input a variety of variables, from monthly contributions through timelines to an expected annual rate of return.

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In the social sphere

Social media

A very helpful reminder here from Calgary-based financial planner Aaron Hector about the important differences between designating a spouse as a successor holder or a beneficiary of your tax-free savings account, or TFSA. And why simply leaving your TFSA investments to them in a will is the least good option.

The money-free zone

Not sure about you, but I’m having a harder and harder time finding something I want to watch on streaming services or at the movies. But here’s a vintage find I truly enjoyed: Klute. Jane Fonda, Donald Sutherland, noir-like vibes and a plot driven by enigmatic characters. Oh, and currently available on Tubi, which doesn’t require a subscription.

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ICYMI

Globe and Mail stories from the last few days

• Ten moves for employees to save tax before year-end
• Hilton’s first Canadian credit card is solid, if a touch underwhelming
• Six ways the Bank of Canada rate hike could cost or benefit you
• Rate hike expected to slow sales in Canada’s slumping housing sector